Few can be more experienced in matters of ESG and sustainable investment than Lee Coates OBE, ESG Accord. In this, the first of his series of articles for IFA Magazine, he looks at the changes needed in IFA firms over the next 12-18 months, in respect of Environmental, Social and Governance (ESG) factors and Sustainable Finance.
We’ve all seen increased coverage of ESG and sustainable investment over the last year, but for IFAs this isn’t just about fund managers shifting new product, as changes are coming to the financial advice process as well.
What is interesting is that ESG and sustainable finance are often used to describe the same thing but the two are quite different in their application. ESG is more about the process and metrics at the fund management end, whereas sustainable finance is a direction, an outcome, a goal for investors. ESG, Responsible, Impact, SDGs and ethical investment can all be used to generate a sustainable finance outcome. The appropriate route to take is the client’s choice, with support from their IFA.
The need for change
Based on FCA guidance, advisers should look at the advice requirements in Europe and align their firms accordingly. This means educating clients, building sustainability preferences into the advice process, and implementing appropriate compliance procedures. These changes are coming to the UK, so it is time to start planning your response now.
The advice process must ensure clients understand what they are being asked and incorporate an assessment of each client’s attitude to the different areas of sustainable finance (ESG, Responsible, Impact, SDGs, ethical etc). Advisers should record whether a client wants to apply sustainability factors in their financial planning and demonstrate they have a process in place to deal with a ‘Yes’ answer from a client. This process should follow the current MIFID II Target Market processes for selecting products and funds. It isn’t good enough to say, “I’ll deal with it if I get a Yes”, as a formal process needs to be in place before the first client says Yes.
A suitable compliance process
Advisers will need a suitable compliance process – see it as an extra section for your existing compliance manual. Regulatory focus will be on due process; ensuring all clients are treated fairly and that appropriate questions have been asked, recorded, and referenced in the product/fund selection. Client responses could range anywhere from no interest to strong moral/ ethical exclusions.
The FCA’s recent Green Finance paper states that investors must have the correct information and tools to make the right choices under sustainable finance and ensure that information is available to allow them to monitor these choices over time. This is about Trust, Transparency and Tools. Investors using an IFA will rely on their adviser to inform, educate, and distil these choices. So, before advisers start asking their client sustainable finance questions, they will need to provide their clients with educational material about the different choices. Not doing so (as well as failing FCA guidelines) is like asking a client about AtR (degree of willingness to accept volatility) and Capacity for Loss without any explanation at all about markets, risk etc.
Before advisers start asking their client sustainable finance questions, they will need to provide their clients with educational material about the different choices
A bad question is going to generate some unreliable information on the client’s file. That’s not a place any adviser wants to be.
Once you are happy a client understands what they are being asked, you’ll need an appropriate method of recording the answers – enter the sustainable finance questionnaire (we call them Values Questionnaires). We recommend a Triage system to make an initial assessment of client values, progressing on to more detailed questionnaires only if needed.
If you have an existing centralised investment proposition (CIP), it isn’t going to work to have a single ‘sustainable’ CIP alongside. A single sustainable option implies all your clients are identical in the way they wish to apply their values (sounds a bit like shoehorning). I believe the sensible option for most firms is the managed portfolio services (MPS) route. Let a discretionary fund manager (DFM) do the heavy lifting on fund selection and focus your firm’s attention on finding the best MPS to meet your sustainable target market groups.
ESG Accord assists firms by cost effectively providing all the appropriate educational material, documentation and compliance processes needed to meet the new rules. This covers pensions, investments, mortgages, equity release etc.
With so much media coverage of climate change, social issues, and governance, firms need to be talking to clients now about their options, rather than waiting until midnight before the rules are implemented. Clients are ready to be advised now. What clients need is for their IFA to help them match their values to their money.
About Lee Coates
Lee spent 31 years running his own financial advice business (Ethical Investors), dealing exclusively in ethical and responsible investment advice. In 1998 he established an independent ethical research company (Ethical Screening) and in 2010 launched Australia’s first animal-friendly Superannuation fund (Cruelty Free Super). In 2011 he was awarded an OBE for ‘services to ethical business and finance’. In October 2020 he launched ESG Accord, an adviser support business assisting firms to implement suitable compliance procedures to meet sustainability preferences requirements.